UK inflation has grown at an annual rate of two per cent for the second month in a row, official statistics confirmed today.
The consumer price index (CPI) figure is bang on the Bank of England’s target. It thinks two per cent inflation is ideal for ensuring smooth growth in the economy.
But what does this mean for the Bank’s main interest rate, which currently stands at 0.75 per cent?
If inflation drops below two per cent, the BoE should theoretically cut rates to encourage borrowing and spending, and vice versa.
However, Brexit uncertainty has made the Bank reluctant to take any action for fear of destabilising the economy.
“There is little pressure for the [Bank] to adjust interest rates in either direction,” said Andrew Wishart, UK economist at Capital Economics, in response to today’s figures.
“There was still little sign of rising underlying inflationary pressures despite the continued strength of pay growth in May,” he said. Official figures yesterday showed real pay grew by 1.7 per cent in the year to May.
“A fall in energy price inflation and a reduction in Ofgem’s energy price cap in October should take 0.3 percentage points off inflation over the second half of the year,” Wishart said.
Investec economist Victoria Clarke said: “For the Bank of England the close-to-target inflation readings helps the institution to maintain its wait and see position amidst continuing questions over Brexit’s likely course”.
“We maintain our view that the BoE is happy sitting tight throughout this year and through much of next year too,” she said.
The way Britain leaves the European Union will be at the forefront of the Bank’s mind. It has hinted it could slash rates to ease the economic turbulence of a no-deal exit.
“On-target inflation gives the Bank of England plenty of room to cut interest rates in the event of sharp slowdown,” said Ian Stewart, chief economist at Deloitte. “The likelihood of the UK joining the global move to easier monetary policy is rising.”
But George Buckley, Nomura’s chief UK and euro area economist, said: “The response of inflation to a hard Brexit may be for a sizeable rise” due to higher tariffs, restrictions on incoming goods from Europe, and a lower pound.
Such a rise would ordinarily trigger a rate cut, but the Bank will likely wait and see exactly what happens to the economy immediately after a no-deal exit, should it occur.
Certain elements of today’s inflation figures, such as lower producer input and output prices, are “helpful for the Bank,” said Howard Archer, chief economic adviser to the EY ITEM Club.
The data gives “decent scope” for the BoE “to adopt a flexible approach on interest rates should the economy continue its current struggles amid Brexit uncertainties,” he said.